A Dash of Insight

Reviewing the Media Pundits: Two Views of the Fed

One of our themes at "A Dash" is the array of challenges to the individual investor.  Interpreting market commentary is one of the most important.  While our readers understand the blogosphere, the influential print media remain far more important.

The MSM articles do not have any comments, so readers are on their own to spot any problems.  To illustrate this, we will contrast today's article by New York Times columnist Gretchen Morgenson with a recent piece by Bloomberg's John M. Berry.

Morgenson on "Trash for Treasuries"

Regional printing has made it possible for people all over the country to enjoy a hard copy of the New York Times with morning coffee.  Our Thursday and Friday editions (during our West coast trip) were printed in Seattle, and today's, delivered at our door, was printed in Chicago.  Many individual investors look to their business coverage.

One of our favorite sources is Pulitzer Prize-winning columnist Gretchen Morgenson.  Her perspective is clear from her background -- history, English, journalism, and a record with publications that make difficult topics clear for average investors.  On most occasions, she does this very well.

Her column today includes all of the hallmarks of good journalism.  She has plenty of sources -- a mortgage guy saying that the Fed is accepting questionable collateral, quotes from Fed officials on the dubious nature of securities ratings, and a pithy quote from the sassy and colorful Joan McCullough calling the Fed a "monetary bordello."  There is a source for every statement.  Every technical point of journalism is covered.

Her conclusion?  The Fed is risking taxpayer money on dubious securities and we might all be left holding the tab.

Her opinion?  "To be sure, crisis times call for creative measures. But as long as Wall Street is allowed to swap trash for Treasuries on the taxpayers’ dime, don’t try to tell me this horror show is over."

Our Analysis

We are disappointed that Morgenson missed the point so badly.  She has written an article where every piece of it is accurate, yet the conclusion is deceptive.

It is not the mission of the Fed to engage in policies with profit in mind, although the net effect of Fed actions does provide "profits" to the taxpayer each year.

The Fed mission is to address the twin goals of economic growth and price stability, while assuring stability in financial markets.

By writing a column that focuses completely on the risk to the taxpayer, without due attention to the Fed mission, she misleads her readers -- mostly average investors.  The colorful language about "trash" emphasizes this viewpoint.

An Alternative View from Berry

John M. Berry has long been recognized as an authority on the Fed, often with an inside glimpse of official thinking.

In a recent article, he makes several important points.  First, the nature of the Fed actions:

The Federal Reserve is supplying the financial system with more than $150 billion in cash, a liquidity cushion that has helped keep enough credit flowing to ensure the economy's growth.    

After another auction of term funds on May 19, the amount of cash from the Fed will probably top $175 billion. And if the system needs still more, Fed Chairman Ben S. Bernanke said in a May 13 speech, the Fed stands ready to supply it.

What has been the effect?  Berry cites some useful data, as follows:

...(T)he unprecedented amount of cash pumped into the system have helped the economy defy predictions of a recession.    

Recent data suggest the economy grew at about a 1 percent annual rate in the first quarter, slightly more than the 0.6 percent estimate released by the Bureau of Economic Analysis on April 30.    

And on May 13, Macroeconomic Advisers predicted that the tax-rebate checks now being sent to many households would spur consumer spending this quarter, boosting growth to 2.5 percent. Third-quarter growth would exceed 3 percent, the forecast said.

The specific lending effects?  More from Berry:

The Fed had no choice except to supply the liquidity that was no longer available in the market. Otherwise, even credit worthy households and businesses wouldn't have been able to borrow, and a recession would have been inevitable.    

Instead, over the 12 months ended in April, commercial and industrial loans rose 20.9 percent at banks, while home-equity loans climbed 9.9 percent and consumer loans increased 9.3 percent. Even other types of real-estate loans were up 6.7 percent over the period.

Our Take

The New York Times readership differs dramatically from that of Bloomberg.  A reader of Morgenson's piece alone may not understand the rationale for Fed actions, nor the important effects on the credit crunch and economic growth.

One of the biggest challenges for readers of opinion articles is to understand what has been left out.

The real story of the Fed initiatives was avoiding the "death spiral" of forced selling into illiquid markets.  Mainstream media have done a poor job in covering this issue.

It is so much easier to write something that will appeal to the "common man" in a way that emphasizes taxpayer risk.  Even if some loans go bad -- far from clear from the data -- the economic benefits dwarf any potential losses.

Investors who do not understand this are fighting the Fed, something we warned about in December.

             

If you cannot pass this investment test, turn over the car keys

Here is a key question for investors and traders alike:  Do you want to be entertained by the colorful opinions of bloggers about what government should do or would you rather profit by understanding what they will do.

Background

We have highlighted the distinction between normative and empirical analysis -- opinions about what ought to be done versus the dispassionate study of behavior.  We suggested in December that the Fed was on a mission, using creative tactics.  We highlighted an excellent article from Abnormal Returns describing the difference between "Positive and Normative Blogospheres."  We have suggested that those offering opinions should first get some information -- at least reading some Fed briefings and old transcripts of meetings.

A Good Explanation

While doing research for our sister site, Election Stocks, where we analyze candidate issues and link them to specific investments, we came across a five-year analysis of the Iraq war.  We recommend checking out our comment on this subject, and the complete study.

Meanwhile, the explanation of the work provides an excellent insight into the distinction between those doing "politics" and those doing public policy analysis.  The report comes from a private sector group.  They make money by providing analysis, not opinion.  The following is the explanation of their mission, taken from the report:

The debate is over whether the invasion was a mistake in the first place, while the divisions over ongoing policy are much less real than apparent.

Stratfor tries not to get involved in this sort of debate. Our role is to try to predict what nations and leaders will do, and to explain their reasoning and the forces that impel them to behave as they do. Many times, this analysis gets confused with advocacy. But our goal actually is to try to understand what is happening, why it is happening and what will happen next. We note the consensus. We neither approve nor disapprove of it as a company. As individuals, we all have opinions. Opinions are cheap and everyone gets to have one for free. But we ask that our staff check them — along with their personal ideologies — at the door. Our opinions focus not on what ought to happen, but rather on what we think will happen — and here we are passionate.

Conclusion

The Stratfor description is exactly what makes public policy analysis valuable.  It is just what we are trying to do at "A Dash."  While we have opinions about what government should do, our mission is in helping investors understand past actions and predict future moves.

Those who do not understand this distinction are failing an investment Breathalyzer test.  They have become intoxicated with the  punditry and the debate over policy while losing focus on the cumulative effect of the many incremental policy changes.  These changes are starting to add up, (yet another future topic.)

Meanwhile, if you do not see the difference in these types of analysis, you should do the following:

Turn over your investment car keys to an index fund manager!

The Fed and Bear Stearns Collateral: Back Door Buying of Mortgage Securities

The just-announced terms for the JP Morgan buyout of Bear Stearns include a dramatically different role for the Fed.

In the last iteration the Fed was taking collateral from JP Morgan without recourse.  In the new version JP Morgan takes the first $1 billion of risk and the Fed the next $29 billion, a change that seems minor, but might well cover any actual losses.

The big difference in the new terms is that the assets will be independently managed in accordance with Fed guidelines.  If there is a profit, it will accrue to the Fed.  This may not constitute legal ownership, but to us, it is a distinction without a difference.

Many of the pundits and CNBC anchors are acting as if they know the value of the collateral.  "Send your toxic stuff to Ben," was one flippant example.  In fact, none of us knows the true value because we do not have a functioning market in these securities.  Some astute observers believe that the underlying loans may perform much better than the market expects.  If this proves to be true, the Fed and the taxpayers may make a profit.  That was not the objective of the Fed involvement.  The motivation was to avoid the systemic failure that might have started with Bear's counter-parties.  The new deal terms accomplish this with a better alignment of risk and reward.

The Fed action is testing the limits of its authority concerning asset purchases.

Whatever one's opinion of the merits, this deal is certainly creative.  It is not something one would see from a Fed that was "behind the curve."  For those who suggest that the Fed is merely reacting to events, we wonder how such an action could have been taken in anticipation.

Updating the Bear Stearns Stock Price Mystery

Last week we examined why Bear Stearns stock was trading above the deal price. We attributed buying in Bear Stearns to Joe Lewis and speculators hoping for a sweetened bid.  We suggested that gaining cooperation and avoiding legal issues were possible reasons for increasing the bid.  We do not expect rival bidding.  With a new deal price of $10, the stock is trading $12.75, off a high of $13.80.

The market seems to believe that the terms of the deal are now open for further negotiation.

[Disclosure:  No position in Bear.]

Who Should be on the FOMC

David Merkel has a very interesting article, A Social View of the FOMC, where he analyzes the background and credentials of the voting members, and also the non-voting bank Presidents.  Readers should download his handy PDF summary and also read his comments on each member.

He is highlighting an important question.  Many have criticized the Fed for being too "academic."  Some seem to believe that a committee of trader-types would be better, or that corporate executives would add value.  David suggests that more economists from the Austrian School would be a plus.  We wonder how that would fit with the many calls for clarity of purpose, like that of Paul Kedrosky.

Some months ago when the FOMC membership was criticized as a bunch of academics we did our own check of the backgrounds.  We were looking for a very specific credential which gets no respect in the financial community.  Even in the astute Merkel analysis, this credential is not mentioned;  in fact, it is given short shrift.

Any guesses as to what this might be?

More broadly, what should a new President be looking for in appointing Fed Governors and considering the reappointment of Bernanke?

Analyzing Fed Critics: Paul Kedrosky

It was a day when many questions would be raised, and a few were actually answered.

It was a time of financial crisis, with liquidity in doubt at several financial institutions.  The Bear Stearns "bailout" is fresh in the minds of all, with many stories asking "Who is next?"  The Fed rate decision was imminent and this time the answer was not known in advance.  Before the opening the world would hear from Goldman Sachs and Lehman.  Many expected big losses and further write-downs of financial assets.

Most of those in the financial community have turned very negative, particularly on the Fed.  Since the ranks of blogging public policy analysts are so thin, we really have a minority viewpoint.  Even our own loyal readers think that we are naive and clueless! (see yesterday's comments).

Our Purpose

We are trying to help investors make money.  This is not via specific investment advice, which we would not offer en masse, but insights about how to use the available information.  This frequently means some careful analysis of prevailing investor and pundit sentiment.

Fed Critics

Readers can do their own tally of today's Fed commentators and pundits.  It would seem to be tough to criticize on a day when the market had a big rally, but most of that was the result of the Lehman and Goldman reports.  Let us take a typical reaction from a leading voice, Paul Kedrosky.  We choose this comment not because Kedrosky is a poor analyst.  Quite the opposite.  Like nearly everyone else, we read Infectious Greed, one of our featured sites, every day, enjoying both the breezy, wide-ranging commentary and the  suggested weekend readings that highlight articles we would otherwise miss.

Having given this measure of well-deserved respect, we are going to disagree completely with his analysis and conclusions.  Furthermore, we believe that Kedrosky's thinking (Is the Fed Confused, or Just Being Confusing?) is quite typical of most trader and fund manager types.  He starts by criticizing both the concept of compromise and academics by writing, "Ben Bernanke has compromised, like any good academic chair should."

He continues as follows:

...(T)his strikes me as somewhat confused. Is it inflation you're worried about? Is it the financial services industry bailout? What is it? Why not get in front of the 2-year and call it a day? Why dodder around fretting about inflation if you really think you're facing a credit market meltdown? And to have two dissenters is definitely material, both citing inflation as a concern. When is the last time we had two dissenters on a Fed rate cut/increase?

Our Reactions

• The criticism of compromise makes sense only if one has a very simplistic view of government.  Kedrosky, like most other critics, turns the FOMC into a unitary actor.  He then expects the group consensus to reflect his personal viewpoint and to quash any dissent.  Wow! Our government is pluralistic and participatory.  Most institutions are structured to reflect a range of interests.  The FOMC is actually much more insulated and narrow than most.  Despite this, there are often genuine policy disagreements.  When this happens, the resulting action reflects a compromise.  In the case of the Fed, anything more than two dissents is a revolution, so there may have been serious compromising on the inflation language.

We wonder why Kedrosky finds this strange.  He has been a member of various corporate committees and board.  Our experience (on many boards including public companies, private companies, and non-profits) is that even when the votes are unanimous, there is often bargaining to achieve consensus.  The world of government is not so different from the world of business in this respect.

Put another way, what is Kedrosky's approach to the lack of a consensus on the FOMC?   The Chair has no power to expel members.  Should we not be seeking alternative viewpoints?

• Financial services bailout.  The Fed has been clear -- quite clear -- that it is treating the reduction of interest rates and the efforts to direct liquidity as two different problems.  This approach is much more insightful and sophisticated than that of the average trader and pundit.  They dealt with the financial issue over the weekend.

• Why not get in front of the 2-year? This is simple.  The majority of the committee does not agree with Kedrosky on the economic need.  It is possible that none of them do.  We watched many pundits today who thought that the Fed should cut only 50 bp's.  Whatever the FOMC does will be attacked by many if not most traders, pundits, columnists and managers.

• The vague objection about dissenters.  We are not sure what Kedrosky thought should be done about this.  These members have viewpoints that disagree with his personal notion of the best policy.  The dissent is meaningful to anyone more interested in understanding and predicting Fed behavior than in commenting on what they should be doing.

Conclusion

We thought the two dissenting votes, from more hawkish regional bank Presidents who happen to be in the 2008 rotation of Presidents who are voting members of the FOMC, were important.  Here was our comment, minutes after the decision, on RealMoney:

The FOMC meetings usually result in a consensus decision. This often means a compromise, including aspects of the policy statement. Today's action had two dissents (favoring less easing). There have been two dissents only twice in the last ten years. The last occasion was in September of 2002.

Those interested in predicting future Fed moves should take note of this. Some members probably believe that actions already taken will begin to show effects. This would be the typical six to nine-month lag.

Here is part of Tony Crescenzi's analysis from RealMoney (subscription required to get all of his worthwhile economic analysis):

While the Fed's decision was not exactly a line in the sand on inflation --- the Fed did cut the funds rate by 75 basis points, after all -- it was strong enough, especially given the two dissents, to put the U.S. dollar on better footing and threaten speculators in the commodities markets.

I expect the dollar to be buoyed and commodities to fall in response to today's action and the Fed statement, if not immediately, then in hours or days.

We agree with Crescenzi and expect the Fed to emphasize the difference between rate-cutting and directing liquidity.  We continue to emphasize this fact:

Investors should focus not on pundits who opine on what the Fed should do.  To profit, it is more important to understand the Fed and predict what they will do.

 

What the Bear Stearns resolution tells us about the Fed

At "A Dash" we read and respect sources reflecting many different viewpoints, trying to find the best sources on various subjects.

The market was shocked today by the terms of the Bear Stearns "rescue."  It certainly was no bailout for the shareholders or management.  There are those who expect government actors to behave like a deer in the headlights.  We have the uncomfortable feeling that some pundits actually want our economy to fail and for many average investors to lose their money, their jobs, and their homes.  Why?  To prove their uber-bearish predictions to be correct?  To sell books?  To lock in short positions? 

Our perspective is quite different, directed at the mainstream of investors.  This is not a game between bulls and bears.  It is about life chances for the many.  We wish that those who are most vocal in criticizing policy would also offer some solutions.

The Reality

The Fed is not playing by the rulebook  of the bearish pundits.  At "A Dash" we have maintained that it is not wise to fight the Fed, and that Bernanke will do whatever it takes to solve the various problems.  It is unfortunate that we do not have a stronger President right now, or even better policies would be available.  There are proposals in Congress, but progress might be difficult.

Today was a day when there could have been a major systemic failure and a stock market collapse.  Instead, timely action stabilized credit markets and counter-party risk.  It was no help to Bear Stearns shareholders, but it was good for the U.S. and global economies.

John Mauldin, collecting information and writing in his widely-disseminated thoughts, observes as follows:

As I have been writing, the Fed gets it. Their action today is actually re-assuring. I have been writing for a long time that they would do whatever it takes to keep the system intact. As one of the notes below points out, this was the NY Fed stepping in, not the FOMC. The NY Fed is responsible for market integrity, not monetary policy, and they did their job. And you can count on other actions. They are going to change the rules on how assets can be kept on the books of banks. Mortgage bail-outs? Possibly. The list will grow.

Yes, tax-payers may eventually have to cover a few billion here or there on the Bear action. But the time to worry about moral hazard was two years ago when the various authorities allowed institutions to make subprime loans to people with no jobs and no income and no means to repay and then sold them to institutions all over the world as AAA assets. And we can worry in the near future when we will need to do a complete re-write of the rules to prevent this from happening again.

This is exactly what we have argued for months.  The Fed will not be constrained by the "old rules" and will basically do whatever it takes.  It is not just about the level of interest rates.

The Logic of Government Action

As we have observed, none of the leading bloggers or media pundits has any real expertise about how government policymakers behave.  Here is a key concept:

Government leadership is difficult!

It is frequently the case that the "best" course of action, selected on some rational basis, is very unpopular.  This is the current case with the subject of "bailouts."  These might be bailouts of investment banks, investors, bad lenders, bad borrowers, and other folks who have screwed up.

A large portion of our society is more interested in punishing those who have made mistakes than they are in looking at the systemic effects.   This pervasive sentiment makes it difficult for political leaders to act.  Getting the average citizen to see the general interest is a major political challenge, beyond the capability of a lame-duck president.

Once again, John Mauldin has an argument, even drawing upon a theme we had planned for a future article (scratch that!):

But for now, we need to bail the water out the boat and see if we can plug the leaks. Allowing the boat to sink is not an option. And get this. You are in the boat, whether you realize it or not. You and your friends and neighbors and families. Whether you are in Europe or in Asia, you would have been hurt by a failure to act by the Fed. Everything is connected in a globalized world. Without the actions taken by the Fed, the soft depression that many have thought would be the eventual outcome of the huge build-up of debt would in fact become a reality. And more quickly than you could imagine.

Our Take

We are delighted that a sophisticated observer like Mauldin has grasped the fact that the Fed will continue to take imaginative and aggressive actions.

This contrasts sharply with most of the media coverage, which continues to portray everyone in government as stupid, naive,  and ineffective.

One of the reasons that people in government choose those jobs over private-sector finance is the desire for power and policy influence.  This is something that is little understood by those who took different career paths.  We suspect that the hedge fund and media critics of the government and the Fed will be getting a lesson about this in the months to come.

Bear Stearns Bailout Implications

Everyone needs some time away, but those of us in the investment world never really get it.  Managing money carries with it the responsibility of monitoring information and staying in touch, no matter how talented the team on the front line.

We are talking with a lot of individual investors.  The doom and gloom is palpable.  It is no surprise that the viewpoints reflect the themes of the popular press and websites.  We plan to return to the broad themes, but let us take today's news as a case in point.

CPI Data

For a few minutes this morning the market celebrated the news that February CPI (seasonally adjusted) was unchanged.  The data critics were warming up.  How could gasoline prices be down?  (Answer:  Look at a chart.  This is February data, compared with January.  People are already thinking March).

There is a reason why those who are not economists and have never actually collected or analyzed data are so critical.  If no one believes the official data, they are free to propagate any argument based upon anecdotal evidence.  With the cost of living,  it is easy to point to items that have increased in price, ignoring any serious methodology or balance.

Bear Stearns

The story, as we now know it, seems to be that Bear suddenly and unexpectedly experienced a broad scale loss of accounts.  Since financial institutions do not and cannot keep enough cash around to meet all redemptions, this "run on the bank" carried a systemic risk.  Counter-parties of Bear might also fail.  Forced selling (yet another round) of illiquid assets would partly meet obligations, but might force another round of write-offs by other institutions.  In a couple of weeks, Bear would have been able to use the new Fed TLAF facility for this collateral, but could not do so yet.  Bear turned to its banker, J.P Morgan and described the situation.  JP Morgan could borrow from the Fed's discount window, but did not want to have the traditional "stigma" that comes with such actions.  The Fed agreed to backstop their action, leaving JP Morgan with no exposure.

What to Conclude

Explained in this way it seems like a success story.  Something that was completely unexpected created a major threat.  The parties involved acted swiftly and effectively.  While stock market traders aggressively sold financial issues, the major system threats were averted.

To realize this, ask what would have happened if Bear indicated insolvency with no support from the Fed.....

Some Comments from the Punditry

Bear lied. [How do we know this?  The "later" story was that rumors became a self-fulfilling prophecy.]

Bear caused the problem when the CEO went on CNBC to explain that "all was well."  Multiple pundits and traders today explained that this was alarming and caused the problem.  [A key feature of a successful CNBC interview is to show how smart you were about something that already happened.  Let's hear from those who caught this contemporaneously.]

The Fed has lost all credibility, according to a featured trader on CNBC.  This is because of  "what they said about interest rates."  [These trader comments are amazing.  The Fed acted much more rapidly than past Feds in similar historical situations.  They adjusted policy rapidly with new data.  We wonder if traders would prefer a situation where the Fed did not respond to data?]

Everyone in power is an idiot.  [Our view is that the Fed has been aggressive and creative.  Bernanke has acted more swiftly than past Fed chairs, and has also used creative means.  The TAF facility was disparaged by pundits at the launch, but was actually quite successful.]

We cannot trust anyone.  [This is the ultimate argument for pundits.  If the average investor cannot trust statements by the Fed, by any CEO, or by the government, then it is open season for those promulgating fear.  Fear sells.]

Conclusion

A top financial analyst came up to me today and stated that no one was bullish.  Everyone he talked to shared the view that all of the government officials were stupid, the data were manipulated, the recession would be severe, technical support had been violated, and the market might crash.  Everyone.

The dilemma.  So many are saying that the market has given a verdict.  If one thinks that the market is always right, in the short term, than there is no edge for the investor or the fund manager.

The Fed, the Economy, and Stocks

Sometimes a concept is so simple and compelling that one would expect it to be universally embraced.  When important government agencies demonstrate a commitment to addressing a problem, investors and traders alike would be wise to take notice.

Instead, stocks have declined dramatically, actually beginning at the time the Fed engaged in cutting rates and initiating the successful TAF facility.  A key point is that Wall Street guru's and pundits all seem to believe that they are better and smarter than those in government.

At "A Dash" we try to find the real experts.  There may be other blogs written by people who have extensive experience in the three relevant arenas - academia, government, and financial management -- but we have not seen any.  (Readers please correct us ASAP).

The choice for the investor is easy.    On the one hand, you can accept the arguments of the market pundits who think that government officials are too stupid and academics are too smart, and both are  therefore out of touch.  Alternatively, you might consider the possibility that some very bright and capable people choose different career paths.  They are all good at what they do.

Outsmarting the TV and Internet Experts

The unending hunger for content makes everyone an expert.  Today the CNBC noontime anchors were swept away by a prediction of an inter-meeting rate cut by the Fed, a prediction made by a young woman who is a strategist for a firm trading fixed income instruments.

She might be correct in her call, but many of the bearish pundits have made two big mistakes:

1. They predicted that the Fed was "in a box" and would not ease aggressively.  Strike one.
2. They next opined that the Fed must stop cutting rates because of a declining dollar and rising commodity prices, something that they accept as a better measure of "inflation."   They were wrong again.  Strike two.

These pundits now think that the Fed is "Pushing on a string."  We hear this prediction from very few actual economists.  This is pretty strange.  We believe that it will be "Strike three."

At "A Dash" our view is that there are plenty of experts on different subjects.  When we are looking for trading insight and stock-specific information, we read and consider carefully the views of Doug Kass (full disclosure -- he is a colleague on TheStreet.com).  His ideas are plentiful, profitable, and worth the price of admission.  He endorses the "string" theory.

When it comes to economics, we prefer the viewpoint of David Malpass, who has had a multi-year record at reading the economic twists and turns with great accuracy.  Last week he weighed in on this topic in a report for Bear Stearns investors, Massive Fed Power--How it Works.

Fed Not Pushing on a String
We think there’s a general underestimate of the power of central banks to stimulate their economies in the short term.
• U.S. recessions have occurred when the Fed tried to stop inflation with high interest rates (1974, 1980, 1982, 1990), a situation the Fed may put off until 2009 or 2010. In contrast, when the Fed has held interest rates down to the inflation rate or below, the result has been strong growth, as in 1977 and 2003.

Malpass goes on to explain how the effects are amplified by the Hong Kong Monetary authority, how circumstances have improved since the August credit problems, and why the economy is likely to expand.  He does not believe that it will "end badly."

The compelling argument is that the Fed is determined to avoid a deflationary spiral.  If you are an investor, that is something to keep in mind.

Will this result in some future inflation?  It depends upon the reaction of the economy and the pace of the Fed in reversing the rate cuts.  While  no one knows for sure how this will play out, it is not a firm basis for investors and traders looking to the remainder of 2008.  That story is one of economic expansion, including both the Fed and fiscal stimulus.

Some Analysis of Rate Cutting

Michael Zhuang at The Investment Scientist has a nice table summarizing stock returns after periods of Fed rate-cutting.  His familiar conclusion is the quote from Marty Zweig, "Don't Fight the Fed."  Readers should check out his article for the full story.

We believe that the analysis actually understates the case.  The current environment is even more bullish since we are starting from such a high level of negativity.  Actual corporate earnings outside of financials remain strong.  The financial stock earnings include write-downs that emphasize current FAS 157 accounting, marking to illiquid markets, rather than looking at future  potential.  It is something to consider.

Conclusion

Market averages are heavily influenced by technical trading, forced liquidations, and sentiment.  As we indicated, there is a sense that January lows must survive a re-test.  We are not anticipating a good employment number on Friday, a subject for tomorrow.

We do not indulge in short-term market calls.  On somewhat longer basis, the averages are still trading at the level when our Gong Model (report available upon request) indicated a good risk/reward for those with a multi-month horizon.

We are also very confident that a solution for monoline insurer problems will be forthcoming.  The market skepticism on this subject has been vastly overdone.  This is an important development for financial stocks, particularly Merrill Lynch (MER).

Full Disclosure:  We are long MER.

The Fed Minutes: An Answer to the Question of "Duping"

On RealMoney last Friday we made an observation that we did not see suggested anywhere else -- rather rare in the days of the blogosphere.  (Readers are invited to send the many pointers showing us to be wrong and lax in our reading!)  Here was the comment:

On Wednesday we will get the minutes from the FOMC meetings of January 30th and January 22nd. This will provide a little more color on the discussions leading to the rate cuts. I am more curious about whether there were additional meetings, not let disclosed, where no action was taken. If past practice is followed, we will find this out on Wednesday. This might tell us something about whether an inter-meeting move was seriously contemplated before January 22nd.

Today's minutes revealed that there was, in fact, a conference call meeting on January 9th.  As is customary when no policy action was taken, the summary of the meeting was rather sparse.  Here is the key part:

Most participants were of the view that substantial additional policy easing in the near term might well be necessary to promote moderate economic growth over time and to reduce the downside risks to growth, and participants discussed the possible timing of such policy actions.

The minutes also covered the meeting of January 21st when the Fed cut rates by 75 bp's little more than a week before the next regularly scheduled meeting.  We suggested at the time that the FOMC must be prepared for more cuts right away.  The motives behind the Fed move were questioned, with many suggesting that the Fed was "duped" or stampeded into action by moves in equity markets, a "folly".  Here is a key segment of the minutes from that meeting (emphasis added):

Such an action, by demonstrating the Committee’s commitment to act decisively to support economic activity, might reduce concerns about economic prospects that seemed to be contributing to the deteriorating conditions in financial markets, which could feed back on the economy. However, some concern was expressed that an immediate policy action could be misinterpreted as directed at recent declines in stock prices, rather than the broader economic outlook, and one member believed it preferable to delay policy action until the scheduled FOMC meeting on January 29-30. Some members also noted that were policy to become very stimulative it would be important for the Committee to be decisive in reversing the course of interest rates once the economy had strengthened and downside risks had abated.

Why is this important?

There was a lot of punditry after the January 21st meeting suggesting that the Fed was not paying attention, that the committee was in panic mode, that they were reacting to markets rather than the economy, that they were "behind the curve", and they acted outside of their mandate.

These allegations were widespread and got plenty of play in the mainstream media.  This is part of the hunger for content that we have described, where bloggers, financial television, and print media alike all love to feature people making bold statements.  It is likely that many investors bought (or rather sold) into this reasoning, helping to create the current market climate.

At the same time we suggested that pundits, while free under the 1st Amendment to offer any opinion, no matter how silly, might benefit from actually learning something about the Fed as an institution.  Especially helpful is looking at actual past meeting transcripts, something that few bother to do.

Our analysis, drawing upon old transcripts and the crucial Mishkin speech, got little attention.  There is more interest in the Monday-morning quarterbacking of the Fed, rather than in actual understanding.  We continue to believe that studying behavior will benefit investors, partly because so few bother to do it.

Conclusions

Here are a few things to think about.

• These meetings do not have leaks.  Not the January 9th meeting, nor the meeting where the Fed set up the TAF facility and swaps with foreign central banks.  The minutes show that scores of people were in attendance, yet there were no leaks.  Interesting.  The Fed is capable of surprise.
• It is a mistake to think of the Fed as a "unitary actor." It is difficult to "dupe" a committee.  That is one of the reasons why the FOMC structure exists.  We saw various comments today that the Fed message is confusing, since there are so many voices.  One CNBC pundit (who shall go nameless here) argued for reducing visibility!  This is astounding.  Market observers who relish information from thousands of different company CEO's on conference calls, and hundreds of different analysts, are suddenly incapable of interpreting data from a few Fed members.  More information is better.  Interpreting the information is a routine task for those with social science training, but that is not a typical skill of traders and fund managers.
• The Fed members are following the Mishkin approach, concerned about overall economic effects.  Market "disruptions" affect the economy, and the FOMC members understand this.  They are not "in a box" since they have and will react to the most pressing considerations.  Right now, that is the threat to economic growth.  They are aware of potential inflationary effects and arguments about moral hazard, but these are not the imminent issues.
• Most importantly, there may be another Fed surprise.  This Fed has been aggressive and imaginative in addressing credit issues.  There may be another action -- outside of the normal realm of interest rate reduction -- should that prove necessary.

The nature of financial media and blogs means that pundits will be pundits.  No special knowledge is required to offer an opinion, to get quoted, or to get on TV.   This means that the burden is on the consumer to figure out whether the source actually has a relevant insight.  It is a continuing challenge.  If the reader or viewer has not himself done the relevant homework -- and few of them have -- they are at the mercy of the financial media.

It would be helpful if the big-time bloggers from mainstream media did an occasional review of subjects like this.  They could do an introspective analysis of their own work, and also take a look at their sources and how they have done.  This would be a useful service to their readers.  Caveat emptor works when they succeed in providing a range of opinions.  When they do not, the process leads to a lack of balance in coverage.

The Key Market Issues

We have talked with many investors to complement our daily monitoring of media treatment of markets.  It is pretty obvious that we have a significant downtrend, based upon a fear that things will get much worse.  Each piece of news about problems gets a lot of attention.  Any company that does not give a rosy view of prospects -- and few are willing to claim this visibility -- gets an immediate hit to its stock price no matter what current data show.

Here are what we see as the key issues:

• Economic Growth Prospects.  Please note that this is not a simple question of whether the economy is already in recession, something that no one can yet know.  This is not a binary situation, despite the media attitude.  An economy that is operating below the growth trend potential hurts many companies and many people.  It affects earnings, but it is not binary.
• The Impact of Lower Growth.  How much will economic growth slow, and how much lower might it be?
• The Earnings Effect.  How much does slower growth affect earnings prospects?  Is guidance valuable?  Are bottoms-up analysts or top-down strategists getting a better read on this?
• How much of slower earnings growth is priced into the market? Current sentiment is to treat each new piece of news as fresh information.  Our view is that many earnings estimates and stock multiples already reflect a very negative result.
• Interpretation of data.  So many seem determined to make two mistakes.  First, they ignore any economic reports that do not fit a pre-conceived outlook.  Second, the punditry -- as opposed to most economists -- finds something wrong with real data -- the best available.
• The Role of Government.  Market participants are unhappy and impatient with government reaction to perceived problems.  This includes Fed policy, housing policy, mortgage availability, and the prospects for the bond insurance companies.  Very few Wall Street experts have any real understanding of how government approaches problems.  Few have such experts on staff, and the "political experts" they have  focus on the election.  Many of those with great media influence are merely reporting the Wall Street reaction to what government is doing.  This does not reflect any real understanding of how problems are addressed.
• Intractable problems.  Which problems are unlikely to be solved, and what might be the effect?

The last of these points is a current focus, to which we shall return in the next few days.  We want to talk about various government initiatives, explaining why solutions are less obvious than the problems.

This approach to the problem is important for investors, mostly because so few know anything about it.  Readers who wish to understand this process should first take a look at our little problem about the Three Business Decisions.